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What In The World Is Going On?

The News From Overseas Hasn't Been Good For Mutual Fund Investors In The U.s.

Here's more bad news for mutual-fund investors who have been fixated on this year's slide in the U.S. stock benchmarks: While U.S. stock funds have gotten roughed up in recent months, international-stock funds are doing even worse.

Diversified international-stock funds are down about an average 12 percent this year, according to Lipper Inc., while the average diversified U.S.-stock fund is down about 3 percent. The overseas-investing weakness is widespread, encompassing funds that buy big stocks and those that buy small ones, in locales from Europe to Asia to Latin America.

The recent performance is just the latest frustration for investors who have heeded the longstanding advice to diversify their portfolios with international stocks. While venturing overseas beat staying on U.S. shores last year, international stocks and funds lagged behind U.S. fare in the preceding four years.

But in spite of the dismal record -- or actually, in part, because of it -- many foreign-fund managers and market watchers say this is a good time to be investing overseas. David Herro, co-manager of Oakmark International Fund, says he has "never seen such a buying opportunity" in Europe in his 14 years in the business. "Really good businesses" in diverse industries including pharmaceuticals, financial services and food are downright cheap, he says.

Further, broad economic trends bode well for non-U.S. stocks. While the Federal Reserve's interest-rate boosts are expected to produce an economic slowdown here, economies in Europe and Asia are in the early stages of expansion. "Growth in Europe is not as strong as in the U.S., but it is also not going to slow down as the U.S. growth is likely to do," says Debby Kuenstner, chief investment officer of large-cap value stocks for Putnam Investments in Boston.

Two words -- "currency" and "technology" -- go a long way toward explaining the underperformance of international-stock funds this year. Currency-exchange trends have worked against U.S. holders of international funds, while tech shares have plummeted overseas as they have on these shores.

In particular, the euro's slide has hurt diversified international-stock funds, which typically have the largest chunk of their assets invested in European stocks. Those shares have tumbled in value, in dollar terms, as the euro has slid around 10 percent against the dollar this year.

Consider the impact of currency-exchange rates on the Morgan Stanley Capital International EMU Index, which includes stocks from countries participating in the European Monetary Union: In local currency, the index has slipped less than 1 percent this year. But in dollar terms, it is down more than 10 percent.

Funds that invest in British stocks also have taken a currency hit, and Japanese stocks have been hurt by currency trends as well, although to a lesser degree.

The flip side of the recent currency hit: Currency trends could soon turn into a positive factor for holders of international-stock funds. Many economists believe the euro will begin to appreciate against the dollar once the U.S. economy slows and interest rates level off, thus boosting the value of European shares in dollar terms.

One factor magnifying the rise and fall of foreign tech stocks: their relative scarcity. "Overseas you're talking about hundreds of technology companies, compared with thousands in the U.S.," says Katherine Schapiro, an international fund manager for Wells Capital Management in San Francisco.

Many of the worst-performing international-stock funds this year are funds that had loaded up on fast-growing tech, telecom and media stocks. Among some such big, growth-oriented funds off sharply this year: Smith Barney International Equity Fund, down 25.2 percent this year, according to Lipper, and Putnam International New Opportunities Fund, down 23 percent. Those funds were hot performers last year, rising 60.3 percent and 105 percent, respectively.

Meanwhile, some of the best-performing international-stock funds this year have been portfolios whose bargain-hunting "value" orientation has kept them from investing heavily in tech. Among them: Longleaf Partners International Fund, up 6 percent this year, and Oakmark International, down 0.3 percent. Last year, those funds gained 24.4 percent and 39.5 percent, respectively.

One reason to invest overseas is to have exposure to markets that zig when the United States stock market zags. Unfortunately, though, "a global phenomenon can swamp any advantage to geographic diversification," says Ed Larsen, chief equity officer for Aim Funds in Houston. He says that has been the case in recent months with the "technology mania" and subsequent meltdown.

Still, over some extended periods, holding international stocks has reduced the volatility of investors' portfolios without hurting returns, notes Bryan Olson, director of Charles Schwab's Schwab Center for Investment Research. Over the 30 years through 1999, for instance, a portfolio combining U.S. stocks and foreign stocks in a 70 percent-30 percent mix performed slightly better than an all-U.S. or all-overseas portfolio -- and with 10 percent less volatility.

The relative performance of U.S. stocks compared with overseas stocks generally "goes in streaks," Olson adds. While U.S. stocks had a great run from 1995 through 1998, for instance, he says there was a six-year period in the 1980s when "international stocks just hammered the U.S." As a general rule, Olson suggests investors allocate 25 to 30 percent of their stock-market money to international stocks or funds.